Is an Employee Ownership Trust sale right for you?

7.5 minute read

Trade, Family Office, Private Equity, or Management Buy-Outs (MBOs) are all recognised exit options for business owners – each with its own pros and cons.  However, we are increasingly seeing a changing trend with shareholders now opting for Employee Ownership Trust structures (EOTs) for sale and succession because they offer significant benefits over the more traditional routes:

• No risks incumbent of an MBO for managers
• Tax-free proceeds under legislation introduced in the Finance Act 2014 – Capital Gains Tax is applicable to other forms of share sales
• Light due diligence and easy-to-follow friendly process
• Valuations in EOT sales can, in some cases, exceed those achievable in a trade sale
• Provides the seller with the option to stay in the business to help maintain stability and retain the company culture

What is the employee sale approach?

John Lewis is probably one of the largest, oldest, and best-known examples of an EOT.  Establishing an EOT creates an indirect form of employee ownership by which a trust holds a controlling stake in a company on behalf of its employees. The business’s ongoing success is of paramount importance to secure your legacy, the employees’ success, and to ensure that the business can meet its future financial commitments to you. A current business valuation and some legal paperwork will not achieve this – consideration also needs to be given to the business model, sustainability, and the transitional process post-sale.

There is significant evidence that employee-owned businesses are more sustainable, take better investment decisions, and are more productive due to employee engagement and their increased focus on success. The main political parties believe the EOT model strongly supports the economy better than the traditional direct ownership models.

An EOT sale does not mean that the business becomes wholly run by the employees. The former shareholders can remain involved at the management level, although they concede board control of the business to a trust, they can take a position as a trustee after the sale. The company directors, working with their advisers, are in control throughout the process and all professional fees are corporately tax-deductible.

The key points of the EOT approach are:

• The EOT must acquire a controlling stake in the company (51% or more) to benefit from the 0% Capital Gains Tax exemption. A 100% sale transaction is simpler and preferred.
• A new company (EOT) is set up and this company buys the shares of the trading company from the vendors via a sale and purchase agreement.
• The company trades as a wholly-owned subsidiary of the EOT company post-completion.
• A trust document sets out the obligations of the Trust to the employees.

How will my business be valued?

A multiple of profit is often used to derive the company valuation and this could be in the region of 4 to 7 subject to trading company financials – but cashflow, financial headroom and reserves will also be taken into consideration. The EOT valuation, which will be led by Avondale, is subject to HMRC clearance and will be assessed using the market indicators and average multiples of recent deals. The Government is actively promoting the employee ownership business model and the proceeds from qualifying sales are currently free from Capital Gains Tax.

How will the sale be funded?

EOTs require funding to purchase the shares and the sources of such funds can be any or a combination of the following:

• Cash Reserves: Cash surplus from the company accounts.
• Vendor Loans: A loan from the existing shareholders to the trust with a typical duration of 6-8 years.
• Third-Party Debt: This can be arranged based on the trading company accounts.

Any debt or vendor loans are structured in much the same way as for a management buy-out and the debt and interest are repaid over time from future profits generated by the trading company. It is therefore important to analyse any seasonality to ensure there is the headroom to make these payments.

The trading company will make payments out of the net profits to the EOT company to enable it to make the Vendor Loan repayments. The vendor loan is often a “promise to pay” and therefore may not sit on the balance sheet. From a practical perspective this means that if cash flow is struggling, the loan period can be extended.

Is an Employee Ownership Trust sale for you?

An EOT may be the best exit option for you if:

• You have a management team that is not keen on a buyout.
• A trade sale could result in a disappointing value or deal structure and would probably be more sector-led than not. You like the idea of remaining with the company as a director or employee.
• Family succession is not an option for you, or you have family working in the business but cannot afford to simply hand the business to them.
• Preserving the culture and your legacy is important to you.
• You want to achieve the full commercial value of the business with the 100% exemption from Capital Gains Tax on the proceeds. Your business does not have the level of recurring revenues which attract higher multiples – therefore a trade sale will result in a lower business value

We believe that EOTs benefit sellers in terms of commercial value and create a stable, purposeful, employee-driven, and strategically advantaged business post-sale.

About Avondale

Avondale is a leading business advisor that helps ambitious owners realise value through employee ownership sales and transition.  These are typically vendor-led sales structured over time to realise the value of the business and reward and empower the team. We are the only advisor providing a turn-key solution that covers legal, financial, trustees, and consulting. This means we deliver the right structure with 0% Capital Gains Tax and work with you and your team to ensure that the new business structure works post-completion.

If you are looking for advice or an exploratory discussion without obligation you can contact us on +44 (0)1737 240888, our Contact Us page or email av@avondale.co.uk for further information? Alternatively, you are invited to join our next webinar “Negotiating the best price for your business” on the 21st of July 2022 by registering here.